The Advantages, Disadvantages, and Overall Utility of Income and Balance Sheets: A Case Study

From the various high profile accounting scandals of the past decade, from the Enron, World Com, and other scandals in close proximity in the early 2000s, to the creative accounting and asset bundling that helped to precipitate the global economic meltdown (and that made certain individuals at financial institutions like Goldman Sachs incredibly wealthy), the world of accounting has been thrust into the public limelight fairly frequently in the recent past. Greater scrutiny of accounting records and stricter regulations regarding the recording and reporting of accounting information is now being demanded by many governments the world over, with companies of course compelled to comply. This of course begs the question, how useful are these accounting records when making business decisions?

This paper will examine the degree to which some basic accounting figures proved advantageous -- and potentially disadvantageous -- to the UK supermarket chain Morrison during its acquisition of Safeway. There is obviously some degree of utility to be found in the income statements and balance sheets of both companies, as these will indicate an approximate valuation range for Safeway as well as the purchasing capabilities of Morrison at the time of the deal. At the same time, there is a great deal of highly relevant and influential information that is simply not recorded on these sheets, and that cannot be expressed in wholly quantified terms. The shortfalls and successes of accounting will be explored below.

First, however, a little bit of background information on the companies themselves would appear to be in order. Morrison has become a much more recognizable name in the United Kingdom and in the business world since it acquisition of the nation's Safeway stores; the number of Morrison supermarkets more than trebled as a result of this acquisition, and the company's market share in the industry rose to twelve percent (Hoovers 2011). This has made the company a true competitor against larger multinational companies like Tesco (which is still the number one food retailer in the UK in terms of volume, market share, and any other conceivable measure) and ASDA (operated by Wal-Mart), and has given the company phenomenal growth over the past year (Hoovers 2011; Morrison 2011).

Safeway, on the other hand, already appeared to be a major international competitor, yet in reality this was more about branding than about an actual business structure. Having operated in the United Kingdom since 1972, in 1987 the company's 133 stores were purchased from the American company by the UK-formed Argyll Group, which then continued to grow and diversify the chain over the next several decades independently of the international Safeway Company (Funding Universe 2003). The company was struggling under the intense competition of the UK food retail industry, however, and in 2004 the buyout by Morrison was approved by both companies' boards and by the relevant UK authorities (Food & Drink 2004). Certain specific environmental aspects of this merger will be examined further on in this paper, demonstrating the necessity to look beyond accounting figures.

Advantages and Disadvantages of Accounting Scrutiny

This does not mean that the accounting figures provided on balance sheets and income statements are without value, of course. One of the clear advantages to using the accounting figures provided by these documents is the ability to conduct side-by-side comparisons of companies and other investment options or growth strategies in a line-item and quantified manner. This is a much more direct (though not necessarily less complex) and objective means of assessing valuation and opportunity cost than areas like strategic analysis, environmental analysis, and other more subjective considerations. A side-by-side comparison of Morrison and Safeway according to 2004's figures shows that Safeway is significantly if not hugely more profitable than Morrison, and is operating at a larger scale. It is interesting to note that the increase in profitability is not commensurate with the increase in overall trade volume; the retail food business does not scale in a linear fashion, clearly.

If nothing other than the accounting sheets were looked at, the merger would almost certainly seem like a good deal. This is especially true for Morrison, which as the smaller of the two companies would be almost tripling its current size in terms of its current assets and annual turnover (a figure that neatly matches the increase in the number of stores Morrison now operates, suggesting similar profit margins, costs, etc.) (Hoovers 2011). At the same time, there are issues that can be pointed out in subsequent accounting records that help to point out the potential disadvantages of relying on accounting figures for merger decisions.

Morrison's 2010 balance sheet shows that its growth in liabilities since the acquisition has outstripped its growth in assets, meaning the company is far less solvent now than it used to be (though it remains fairly solvent today). In addition, the income statement shows that Morrison actually made more gross profit in 2004 than it did in 2010, and though its operating profit has nearly tripled this suggests that the costs of running a business chain of this size is beginning to erode profitability. This apparently negative news, however, is more a reflection of the disadvantages of a reliance on accounting methods and a lack of consideration for other factors than it is an actual sign that this acquisition was a bad idea. The 2010 numbers reflects sales and profitability whilst the world is still in the grips of uncertainty and possibly a recession, which is not explicitly stated in accounting records, and these accounting records also are not equipped to deal with the many other essential considerations that exist when examining a potential investment or acquisition.

Internal and External Considerations

One of the major drivers of this particular merger or acquisition was the fierce competitiveness of the UK food retail industry, which is still rampant (Hoovers 2011; Funding Universe 2003). Tesco and ASDA both retain very strong market shares in this sector, and Safeway and Morrison were feeling the squeeze from these two as well as from Sainsbury (less of a competitive threat now) in 2003, when the initial buyout offer was made (Hoovers 2011; Food & Drink 2004). Consolidating was not necessarily about increasing profitability, but about survival.

The competitive forces in this industry were a key factor in the decision as to whether or not a merger would be acceptable to both companies, and in fact as soon as Morrison made its offer to Safeway it found itself competing with other offers from its major competitors -- something that was stopped by regulations in place to ensure competition, much to Morrison's benefit (Food & Drink 2004). These forces and circumstances are not shown on any accounting sheets, yet are an invaluable piece of the overall merger and acquisition puzzle. Other external considerations, such as the branding potential that existed for the chain now that it would no longer be associated with a large United States-based company, were also doubtless considerations when determining a valuation for the merger, as advertising and future marketing strategies are part of any decent business plan.

There were also several internal considerations that made the merger and acquisition more desirable than an examination of accounting records alone can demonstrate. The cost savings that was expected to be generated by the integration of the two companies' distribution networks as well as the integration of marketing efforts and other company-wide operations was projected well into the hundred-millions annually (Food & Drink 2004). While the accounting records do not show that profit margins increased considerably (they actually appear to have shrunk slightly), this does not necessarily mean these savings were not generated. It is likely that margins were hit by price cuts that incentivized shopping during the recession, and further…[continue]

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